Welcome to the Bodycote conference call. Throughout the call, all participants will be in listen-only mode, and afterwards, there'll be a question-and-answer session. Just to remind you, the conference is being recorded. I'll now hand the floor to Stephen Harris, Group Chief Executive. Thanks again.
Good morning, folks. Stephen Harris here. I'm with Dominique Yates, of course, the CFO.
Morning.
I will be just taking you through a bit of an overview of this Ellison acquisition, and answer any easy questions. If you ask any difficult questions, of course, Dominique will pick those up as usual. So if we just start off, the Ellison Group is a business that we have long admired, actually. We've been in contact with them for many years, trying to acquire the business. And it has never been for sale up until very recently. And unfortunately, and tragically, what happened was that the owner-manager died unexpectedly, and then the estate decided to auction the business off, and we were fortunate enough to win that auction. We know the business very well. It's a hand-in-glove fit for our existing surface technology business.
Ellison's got five production site and an offices site. Our own surface technology business has got seven sites across Europe, primarily, then two in the U.S. You'll have heard us talk in the past about surface technology as being a key area in our specialist technologies that we wanted to expand. And indeed, we've even talked about potential surface practice, surface technology. We've said that there have been some other targets in this area, and indeed, Ellison has been a prime one of those. Ellison's a sort of smaller version of Praxair Surface Technologies without the distraction of the powder and equipment sales that go along with the Praxair. And so it's a much purer play for us.
It's much more in line with our service model, and it's a great fit. The business is currently about 88% aerospace and defense. But with the growth profile that the business has got, we expect that to be up in the mid-90s in short order here. In 2019, the sales will be just over $58 million. And our expectation is that EBITDA is around $12 million. This is all in dollars. That brings our total Bodycote surface technology sales revenues to around $88-$90 million. So a nice piece of the group at this point. Ellison grew its revenues by 16% in 2019, and we would expect similar growth in 2020.
Now, that excludes any 737 MAX impact, which we can talk about a little bit later. The revenue growth that we anticipate for Ellison is underwritten by contract wins and contracted volumes, albeit they're not take-or-pay contracts, but they are guaranteed share of market contracts. And if one backs that off against expectations of the growth in the business, then you can see that our expectations for future growth are pretty well established. Very little of our expectations are based on speculative business; it's all contracted volumes. The margins in the Ellison Group are somewhat lower than we would expect in a specialist technology business like this.
The primary reason for that is that it carries quite a large engineering contingent, and indeed, it's that engineering contingent that's helped it get a prime place in the supply to General Electric, which is one of the primary customers here, and its supply chain. And the kind of platforms that the business is supplying to is the LEAP-1A, LEAP-1B, GEnx kind of engines that we've been growing ourselves in Bodycote on these platforms, and very good future growth prospects. The engineering the business carries is an expected benefit we see going forward, and we will be leveraging that. I'll talk about that a little bit in a second.
We would expect this business' margins to improve to be more in line with our specialist technology profile that we expect. As a reminder, we expect our specialist technologies to have margins around 30%, and we expect this business to get to that kind of point. There's a couple of means, really. One is the natural operating leverage that will occur as this business grows at this rapid rate. And of course, things like engineering and other overheads, we would not expect to be growing. We include in the margin expectation the hard synergies that we've identified here, the cost synergies, of which there are quite a bit.
But we haven't put any value at this point in time on the sales and engineering synergies, which we think will be quite large, but will take longer to kick in, and they'll provide even more value. Examples of the kind of sales and engineering synergies are currently in our European business. In Bodycote, we do quite a bit of landing gear work. This is where we're putting thermal spray onto landing gear as a replacement technology instead of hard chrome or cadmium. You use thermal spray to coat the landing gear. And that's not something that Ellison's done a lot of work in, and we would expect our customer approvals and technology to actually transition over to Ellison. Equally well, we do very little engine work in the existing Bodycote business.
What work we do is primarily for people like Rolls-Royce and not General Electric. We would expect the approvals and technologies that Ellison has to transition over to our European business and help us to penetrate the CFM Alliance to provide surface coatings for that business in Europe. And in general, the significant engineering expertise at Ellison will help us drive more penetration in our business in total. So we see quite a good future here. The business is very exciting for us. It's exactly what we've been looking for. And it will be a quite good step forward for us. If we just talk a little bit about the 737 MAX issue.
We've done an estimate of what a complete shutdown on 737 production will do, and if people stop producing on the LEAP-1B, which is the engine that marries up with the 737 MAX, and we don't take account of any increase in sales of the LEAP-1A, which, of course, is what goes on the Airbus variant, then we would expect Ellison to be hit by about $2 million a quarter. Current expectations are that this shutdown is gonna be in Q1. But of course, that doesn't necessarily mean the engine builders are going to turn off completely. And indeed, there is some indication that there's a switchover of capacity to the LEAP-1A, which will offset some of the 1B shortfalls anyway.
And while we're talking about that, just a note on the impact on Bodycote in this situation, that would be about $4 million per quarter with the production on the LEAP-1B effectively on stock. That doesn't include anything from our HIP business, because we've been told by the investment casting companies that, in fact, this issue is a bit of a blessing in disguise. They are so short of capacity, they've got a large backlog, and they're gonna use this period to actually catch up on some of the backlogs. So this is primarily on the non-HIP business in Bodycote. Either way, it's foreseen to be a delay of business, in other words, pushing it to the right as opposed to a complete loss of business.
So time will tell. We don't exactly know what's gonna happen with the 737 MAX, of course. Nobody does at this point. But that's the impact. One way or another, the impact is small in terms of the Ellison acquisition. And I'll say it again, I think this Ellison acquisition is about as pretty as you could get. I mean, aerospace multiples are high anyway. We've seen that in the past. Given our synergies and the actual benefits we've got with this going forward, we think the net multiple that we've created is actually very reasonable. With that, we'll hand it back for questions.
Thank you. If you wish to ask a question, please dial zero, one on your telephone keypads now to enter the queue. Once your name has been announced, you can ask your question. If you find it's answered before it's your turn, you can dial zero, two to cancel. So once again, that's zero, one to ask a question, two if you need to cancel. Our first question comes from the line of Andrew Douglas at Jefferies. Please go ahead, your line is open.
Good morning, gents. Just two quick questions from me, because you've, you've answered most of them. The contract wins that you talk about, which are helping to underpin, 2020 growth and then beyond. Can you give us a rough indication of, of how long those contracts last for? Are they one-year rolling? Are they five-year, 10-year? If you can help us on that. And also, just thinking about Ellison as a whole, can you help us a little bit understand which platforms you're exposed to? I'm assuming it's, it's most, it would be helpful just to have a, a feel, you know, for the split between Boeing and Airbus and across the different platforms. Any help you can give us there would be great.
Sure. Do you want to pick up on the first question?
Well, I think on the contract wins, they are varied in length.
Okay.
In terms of the length to which the contracts exist. But the nature of this business is that once you've got it, and the history of their business would indicate that once you've got the work, you are in a very good position to retain it going forward. So, it's really looking more at the life of the platforms and the future aircraft deliveries, and that those prospects look very good.
I'll put a bit of color on that, Andrew, for you.
Thanks.
The shortest contract is a year, the longest contract is 15 years.
Okay.
Of the two, the shorter ones are the better ones. Because, what happens on the shorter ones, of course, is you always get to renegotiate prices.
Yeah.
The 15-year ones tend to clamp your ability.
Yeah
to increase prices beyond a certain level. But generally speaking, the contracts are very, very healthy. We see no problems with these. And it's very good understanding. In terms of the platform exposure, so this is a U.S. business only. The platforms, obviously, it's primarily around the GE engine base, in terms of the aerospace and defense business. And those are the engines I just described a moment before. The European, so that basically is the hot sections for the LEAP-1A and the 1B, because the way that works is the Airbus variant, the 1A, the hot section is done in the U.S., and the cold sections are done in Europe, and similarly, for the 1B.
So they split both platforms, engine platforms, across the continent, because versus hot section and cold section, and the Ellison work is primarily hot section work. Just to give people an idea of the kind of work that's going on, we're talking about what's generally referred to as environmental barrier coatings. These are the, the coatings that go onto the blades and the discs and the likes, that protect it from the extremes of the environment that they see. It's also the, abradable coatings, and these are the coatings that are, sprayed in, and form the basis of the seals, the gas tight seals in the engine, so that when the engine first starts up, it abrades away into the coating to actually create the seal.
That's the nature, you know, in a nutshell, very quickly, it sounds easy, of course, of the kind of work that's being done here. Just to comment on that, a large portion of the work that we're talking about here is on a new engine build. In fact, the profile of new engine to aftermarket is unknown. It's a bit like the Bodycote business. We don't know where the component's going into a new build or an aftermarket build. What I will say, though, is that on GE platforms, because GE do a lot more repairs than replacement, whereas Rolls-Royce, for example, do 100% replacement, the aftermarket work on GE engines tends to be smaller. But having said that, there tends to be a lot more of them.
So, I just suppose you're going forward as the new engine builds start to slow down, there will be quite a large installed base, at which there'll be a smaller percentage, of course, as I just mentioned, for aftermarket.
Perfect.
That was the question you didn't answer.
That's a follow-on question. Thank you.
Thank you. Our next question comes from the line of Harry Philips at Peel Hunt. Go ahead, your line is open.
Good morning, everyone. A couple of questions, please. Just in terms of the sort of reference to the sort of tax elements, and the difference between the gross number of $200 million and $170 million, if you could just take us through, Dominique, how that works. I'm presuming you pay $200 million, and then obviously take it back through the tax line in coming years. And then secondly, just to be, just to be very clear on your sort of guidance around 737 MAX and complete shutdown, is that revenue or profit, please?
I go up on the tax. Yeah, the tax benefits derive from, in part, the financial structuring of the business, but the main element is the ability in the U.S. to effectively amortize goodwill on an acquisition over a period of time, and thereby take that as a tax deduction. So, that's the main part of the tax benefit. And you're quite right, yes, that benefit will come through in a lower tax rate going forward than we would otherwise have expected. And we think that that benefit is gonna be somewhere in the 1%-2% range for the coming years.
So when you if we had, sorry, if we had 25 in there, for putting 23, 23.5, would be the appropriate thing to do?
Correct. Or order of magnitude, yes.
Yeah. Perfect. Thank you.
As far as the numbers on the MAX are concerned, I was quoting you revenue numbers.
Yeah.
On a conservative basis, you could say that each $1 of revenue lost is probably worth $0.60-$0.70 of profit. But that's probably a conservative estimate there. It's probably less than that, but that's about the best guidance we can give you at this point.
Perfect. Thank you very much indeed.
Thank you. Our next question comes from the line of Andre Kukhnin of Credit Suisse. Please go ahead. Your line is open.
Good morning. Thanks so much for taking my questions. I'll just go one at a time. Firstly, I wanted to ask about the top-line progression of this business in 2019 versus 2018. It seems to imply a 50% drop-through. Is that kind of normal for this business? Is that something we should think about as a modeling rate, or is there anything unusual going on in 2019?
Yeah, Andre, so, first of all, could you just let us into the secret of how many questions you're going to ask?
3 or 4? That's it.
Yes. Okay. In terms-
Okay.
Expecting what length of the long haul we've got here. In terms of the drop-through that we saw in between the two years there, yes, it's around 50%. That is what we would expect on the upside, roundabout. I just quoted a downside number of 60%-70%, as a conservative number, on the downside, but it's that order of magnitude. 50% is about what you should model in on an increasing revenue basis.
Great. And maybe just short-cutting to the cost synergies question to ask, how quickly do you think it'll get to 100% margin in this business, given the growth profile and the scope for synergies that you see there?
... I would expect it to take a few years, actually, because we won't get to 30% margin purely on cost synergies. We will need the sales synergies and the engineering synergies to come through as well. And by their very nature, I mean, it takes 1 year to get the cost synergies to come through. The sales and engineering synergies, they'll take at least 2 years to start. So you're really talking 3-4 years out before we get up to the 30% level.
Great. On growth profile of this business, a very clear indication for 2020, so thank you very much. But beyond that, do you think it sustains that sort of double-digit growth, based on the order wins, and indications you're seeing right now? Or should we think about this as more of a high single digit growth?
Well, I don't think it'll sustain that kind of growth rate forever, Andre, I have to be honest with you. We're not that starry-eyed about it. But we do see that kind of growth rate for a couple of three years here. Thereafter, we're modeling a growth rate that is going to fall down to around the normalized engine growth rate, plus a bit of aftermarket. So we're talking mid-single digits eventually here. That should continue for quite a long time.
But if you're here over the next 3, 4 years, you see that, kind of, double-digit 15% growth rate for this business?
2 to possibly 3.
2-3. Sorry. Yeah. Great. And then just last one, a broader question on acquisitions, after Ellison, obviously, it's a large deal, and has taken a lot of resources. But once that's kind of settled and I'd say integrated, what is your appetite for M&A beyond that, and is there a pipeline for that?
The answer is, we do have an appetite. We aren't going to rush into anything. I mean, we try to be very disciplined about, acquisition spend in terms of the value that we, pay. And, we've done that here with Ellison. We're not going to splash the cash about. I would say that, this acquisition provides us with, a lot more growth avenues. Interestingly enough, it provides us a platform into some interesting other areas, in, engineered coatings, that we didn't really have the scale for or the expertise for before. And that brings on some more, targets onto the radar screen, so very helpful from that standpoint.
I would say, just a word of caution, though, it probably pushes the very large acquisition targets a little bit further away, into the distance, if at all.
Got it. Excellent. Thank you very much for bearing with me.
Thanks, Andre.
Thank you.
Thank you. Thank you once again. If there are any further questions, please dial 01 on your telephone keypad now. Okay, there seems to be no further questions at this time. I'll hand back to our speakers for the closing comments.
Well, thank you, everybody. Thanks very much for joining us this morning. Dominique, I look forward to seeing you over the coming weeks. Take care.
Cheers.
Thanks. Now to close the conference. Thank you all very much for attending. You may now disconnect your lines.